But the rich pay a lot of tax, so they should get a big tax cut

Of all the pro-taxcut arguments cropping up over recent days, the one I’ve heard most frequently is "well, the rich pay more tax than the poor, so they deserve a bigger tax cut". This argument has a superficial appeal to it, but I think it’s based on a misleading premise. Let me try to explain why.

When we talk about spending measures (eg. introducing a baby bonus, putting in place a private healthcare rebate, subsidising people to watch Big Brother), we tend to compare it with the status quo. In other words, how will this measure improve overall well-being, and how will its gains be distributed among rich and poor?

Economically, there’s no reason not to take the same approach with tax reform. The right question to ask is: "compared to the world we live in now, what impact will tax cuts have on efficiency and equity?". Those who argue that the rich should always get a bigger slice of every tax cut aren’t doing this exercise. Instead, their implicit comparison is "compared to a world in which we have zero taxes and the government doesn’t exist, what impact will the new tax scales have on efficiency and equity?".

So next time you hear someone argue that when we cut tax, more should always go to the rich, ask them whether they think that when we introduce a spending program, more should always go to the rich. Because in equity terms, giving $6.9 billion dollar Kerry Packer a $4500 tax cut is no different to the government cutting him a $4500 cheque.

* There are actually some reasonable arguments in favour of cutting top tax rates, mostly coming out of the optimal taxation literature. But when you take into account the effective marginal tax rates that arise from our highly targeted welfare system, it starts to look as though the big disincentive problems are much more likely to be at the bottom of the income distribution than at the top.

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9 Responses to But the rich pay a lot of tax, so they should get a big tax cut

  1. Sinclair Davidson says:

    I’m not following your argument – I’m sure it’s very clever.

    I don’t know anyone who is saying the ‘rich’ should get more of a tax cut. The mechanics of cutting tax gives the ‘rich’ more. When I compare the government and ALP tax cuts each gives the ‘rich’ more. This is not an argument over principle, just an argument over equally arbitrary numbers.

    The other problem with your argument, as I read it, is that there is no difference between the words ‘give’ and ‘earn’. To my mind, there is a huge difference between not taking $4,500 from the Andrew’s and Sinclair’s (we are ‘rich’ – Kerry’s wealth confuses the issue) and giving us a cheque for $4,500.

    ps. could you make your footnotes slightly bigger – the eyes are getting older.

  2. spog says:

    I don’t think this makes sense Andrew. Lets go to a very basic issue – how much tax cut does a person who pays no tax get? I think the answer is probably zero, making an equal benefit approach rather difficult.

    Or another. Suppose you devise a delightful, pleases everyone (!), progressive tax system. Not long after the Leigh scale is introduced, inflation/wage growth leads to calls for something to be done about bracket creep (or increasing average tax rates). How will you fix it? If you reset all the tax rate thresholds by adjusting them for CPI, you will give more to the rich, for which you will be criticised (and you would appear to be among your own critics). Instead, you fiddle about so that everyone gets the same “benefit”. To your horror, you find that you’ve moved the system away from the finely tuned progressive scheme you started with, toward a flat tax regime.

    The two things are irreconcilable. People who want progressive tax systems have to live with higher cuts to the rich. People who want equal, or more equal amounts of cuts/benefits have to live with losing a progressive system.

    Or am I missing something?

  3. spog says:

    I suppose the obvious retort would be “a brain”, so I’ll get in first with that one.

  4. Andrew Leigh says:

    Sinclair, I’m sorry if this seemed clever – I’d actually been aspiring to “obvious”!. If we just think about this as a question of how much money a rich person has, and how much money the government has, then giving the rich person a $4500 tax cut is precisely equivalent to keeping their tax rates the same, and writing them a $4500 cheque.* My point was that from an equity point of view, we should regard the two as equivalent. There’s a view I’ve heard quite a bit over the last week that the former is somehow different (from an equity perspective**) than the latter.

    Spog, your point seems to be that my argument can be reversed. If the rich family with child suffers $3000 of bracket creep, then from an equity perspective, this is identical to saying that they can’t have the baby bonus. I’m comfortable with this.

    * My tax cut is about 1/3rd of that amount, so I feel justified in using “them”.

    ** I keep saying “from an equity perspective”, since I don’t want to neglect the fact that taxes distort behaviour. But as I’ve read the argument I’m responding to, it’s about equity, not efficiency.

  5. Sinclair Davidson says:

    I don’t mean ‘clever’ as a prejoritive. I’m taking the view that just because I don’t understand the argument doesn’t mean it’s wrong.

    In this instance, Spog is about right. The ‘high’ tax cut for the ‘rich’ is a mechanical application of reversing in the tax system. Perhaps if they had increased the lower thresholds and lowered the high thresholds the ‘poor’ (or ‘not-rich’) might get more than the ‘rich’, but that’s not a tax cut.

    Keeping the tax unchanged while writing a cheque for $4,500 (or whatever the Andrews and Sinclairs get), cutting taxes by $4,500 is only in the same in blackboard economics. There are surprisingly high transactions costs in collecting tax revenue, also I don’t trust the government to pay the $4,500 back each year. (Surprisingly, neither do the banks – the waiting period on a Reserve Bank cheque is the same as any other cheque). That fundamentally, is the problem with the neo-classical theory of public finance: it relies on blackboard economic assumptions of (a) zero transactions costs, (b) governemnt being mindless, but trustful, (c) diminishing returns to money (tax is on money income, not wealth). Hopefully my op-ed of the last point will come out soonish.

  6. spog says:

    Andrew, I’m obviously not putting my point across at all, because I can’t see how your response is relevant.

    All I’m trying to say is that unequal tax cuts (ie, larger to the rich, and none to people who don’t pay tax) are an inevitable feature of a progressive tax scale with a tax free threshold. As soon as you introduce concerns about this result (the rich getting more) you inevitably move away from your original progressive system toward a flat tax system.

    I think the tax cuts are too skewed toward the top end of town, but my concerns about that are reduced somewhat by the simple fact that some of that is an inevitable feature of progressive tax systems.

  7. Andrew Leigh says:

    Spog, I don’t think giving a lot to the big end is an inevitable feature of progressive taxation. It’s what happends when you make progressive systems less progressive.

    Sinclair, I can’t envisage how the marginal utility of money could possibly not decline, so I’m looking forward to seeing your oped. If it’s in the AFR and you want us all to be able to read it, I’d be happy to post it here (with your permission, of course).

  8. Sinclair Davidson says:

    Sure. They’ve also got a lies and stats piece (economics of time travel) and they like to spread authors out so it might not be soonish. Basic idea: (1) You can’t eat money, (2) Money is fungible. Most of the piece, however, is the flip side to your original post. (I don’t argue anybody should get more).

  9. spog says:

    I didn’t actually say that giving a lot to the big end is inevitable, just that giving them more than the low end gets is inevitable. That assumes, of course, that one retains the existing degree of progressivity.

    Sinclair briefly mentioned a way of delivering more equal cuts, and you’ll note that in doing so, the system became less progressive.

    Don’t get me wrong; I’m not defending the tax cuts. I am looking for a rational discussion about their appropriateness, rather than knee-jerk assumptions that they are entirely directed toward the wealthy because of some pro-rich agenda. There may be some of that, but until someone presents something compelling otherwise, I’ll remain convinced that it is also in part merely a product of progessive taxation.

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